Why Commercial Real Estate’s Final Conclusion Is An Excellent Tool For Investors

Buddy picked me up at my office and we rode to the beach in Pinellas County to meet with his customer. I took my laptop and prepared to underwrite the loan on the Final Conclusion software program and wrap up the deal for Buddy on the spot. 

The subject, a 30-room beach front motel, had just been renovated and frankly looked brand new. It was evident the owner had pride in his business. I listened as the very nervous, but excited client talked about how much money he had spent since purchasing the facility over two and one half years ago. He bought it through a real estate agent, who had negotiated the terms for him (he got great - below market - terms from the seller). As with many smaller motels in the area, the seller carried back a mortgage (wrapping two other mortgages he had assumed when he purchased it a few years earlier). The motel had been running a pretty good occupancy in-season - not unusual for projects on the beach, but was in a pretty bad state of repair and had not been doing that well during the seven months off-season. The client, who moved to St. Petersburg from Chicago after retiring from a large public corporation, had paid $3,000,000 with $1,000,000 down. The seller carried back a mortgage, amortizing over 20 years, with a 3-year balloon, which was coming due in less than 2 ½ months.

Investments had been good for this gentleman and when he and his wife decided to retire and buy a "small" business in Florida, they thought their dreams had come true in finding this potentially gorgeous spot on the water. And gorgeous he had made it. He had spent almost another $1,000,000 in renovations. It had been a 40-room motel when purchased. He added a game room for kids, put in a small "continental breakfast lounge" and converted 6 of the rooms into nice mini-suites, thus eliminating 10 of the rooms. "I know I went overboard," he bubbled, "but once I got started it was like a new toy, I just couldn’t stop." I congratulated him on his final product and said, "well, let’s get down to the numbers!"

"Why, I asked, did he wait so close to the expiration of the mortgage before commencing getting refinancing?" He explained that several months ago, he contacted his real estate agent, who turned him over to a mortgage broker. He had been advised that financing would be easy to obtain and left it to the "experts." He began to get a little worried after a couple of months, when he had not heard from anyone, but when he called the mortgage broker, was told, "NO PROBLEM!" "I’ll have this wrapped up shortly." No problem, boy, sometimes I think this is a phrase tendered mortgage broker prospects at their State Licensing Training. Anyway, the bottom line was, the broker did not perform, and he was now desperate. He had spoken to his seller (mortgage holder) and had been advised that, "No, he was not interested in extending the term." He had needs too, and wanted his money.

It is heartbreaking any time I have to say no to a prospective client. It is absolutely the most burdensome task one in lending (of any kind) has to do. But . . . this poor man (and by now that was literal) had over $4,000,000 in this project and the most it would support was a $1,500,000 loan. He was going to have to come up with another half-million (he didn’t have it) just to refinance. Why? With occupancy so low during the 18-month renovation stage, the motel wasn’t showing enough NOI to cover the debt on a $2,000,000 loan. Even going back and using "preconstruction" statements, and blending them into the current operating income and expense report, the loan just would not make sense. It took about 30 minutes to enter and print the report for his scrutiny. We were able to get a loan after he borrowed enough money from his brother (who became his partner) to escrow 2 years worth of "shortfall" NOI. This allowed the lender to book a satisfactory loan with, at least the semblance of a proper DSC.

What created this problem? First, the original balloon term was inadequate. Most facilities need at least one, perhaps two years to stabilize their occupancy to obtain maximum financing. Secondly, his original mortgage broker had no idea what he was doing. "Sitting" on the loan for so long put the client’s investment in jeopardy. And not knowing the proper underwriting techniques was trying to get lenders to look at the project using a 120% DSC. When underwriting almost any motel project, most lenders require at least 140% and often need 145%. A good mortgage broker acting for the customer - at the time he made the purchase - could have advised him of these points and together they could have projected into the future allowing the client to: negotiate a better loan balloon and be more reasonable in handling his renovations.